Why This One Insurance Product Could be The Most Important
Here we will unpack what disability insurance is, the different types, how it works, and why you need it.
Disability insurance is a type of coverage that will provide you with a percentage of income if a disabling event inhibits you from being able to work. You may also see it commonly referred to as income protection.
You have probably heard that life insurance and health insurance are both essential. What most people don't know is that disability insurance is just as vital. Your most valuable asset is the ability to make a living. However, disability insurance is often overlooked, since most people don't want to think about a debilitating accident happening in the future.
Many things can happen to us that won't take our life but may inhibit our ability to make a living. Breaking a limb, loss of use of a hand, or a traumatic brain injury are all common injuries that for many of us means reducing or changing our employment. According to the Social Security Administration, one in four of today's 20-year-olds will become disabled for at least 90 days before they turn 67. Yet surprisingly, 68% of non-government workers currently are not covered by disability insurance.
If you live paycheck to paycheck, have small or no savings, or provide for dependents, then it is crucial to cover your salary in case of an unforeseen accident.
There are two main types of disability insurance: short-term and long-term. These products are meant to be purchased and used together; once short-term disability insurance ends, then long-term insurance kicks in.
Short-term disability insurance temporarily protects the insured from loss of income if you are unable to work due to an injury, illness, or accident.
It will typically cover 60% to 80% of your income.
Short-term disability insurance will cover injuries, illnesses, and often pregnancies. (It is important to know disability insurance is different than workers' compensation. Therefore, anything that is not work-related falls under short-term disability insurance, whereas work-related injuries will fall under workers' compensation).
In states that do not require that employers provide maternity benefits, short-term disability is many women's only option for maternity leave without losing income.
Benefits typically last 3 to 6 months but can continue for up to a year.
The benefits will begin right away or within 14 days, depending on whether you are suffering from an illness or an injury.
Long-term disability insurance provides a portion of income to the insured for years, even decades, depending on the policy.
It typically covers up to 60% - 80% of your income.
Long-term disability insurance has a long waiting period before the benefits begin, typically around 3 to 6 months after the disability occurred. Therefore, long-term disability insurance will usually start once the short-term disability insurance benefits end.
When applying for long-term disability insurance, there are two main decisions to make about your policy: the length of your elimination period (waiting period after the disability), and the length of your benefit period. The length of each term is dependent on what you can afford and how long you can live without benefits after a disability.
The benefit period can last a couple of years, decades, or until retirement. This length of this period is the most significant decision you will need to make when purchasing long-term disability insurance. According to the Council for Disability Awareness, the average disability claim for an individual is a little under three years.
Insurance companies will also make sure that you are not overlapping your long-term benefits with your short-term ones.
Long-term disability insurance needs an elimination period to ensure the insurance company that your disability is indeed long-term.
The elimination period can be anywhere from 30 days to a year until you begin to receive benefits after your disability.
The benefit of having a more extended elimination period is receiving lower premiums.
Keep in mind that benefits typically come at the end of the month; therefore, you could be adding about another 30 days, depending on when your disability started before you begin to receive any benefits.
If you do not have a short-term plan to cover your income while you are in the elimination period, it may cause a lot of stress or even debt. To prevent debt, experts say to have an emergency fund with 3 to 6 months of living expenses. You will have to re-build your fund if used during an elimination period; however, that is much better than dealing with debt.
Long-term disability insurance falls into two groups,
Any occupation disability insurance covers those who can no longer perform work within any occupation, not just their specialized task. This policy is typically harder to receive benefits for but is the significantly less expensive option for long-term disability insurance.
Own-occupation covers those who become disabled and are unable to perform within their specified occupation. The insured will receive benefits, regardless of whether the person can work within another field.
For example, if a surgeon breaks his hand he can no longer perform surgery and work within his occupation. However, if he then becomes a professor, he would still qualify for benefits under own-occupation disability insurance because he is unable to work in the field that he filed under when obtaining the insurance. Own-occupation is typically more expensive, but if you can afford it, this is the recommended option since claims are much more often approved.
People may assume just because they have an office job or a job with minimal mobility, that they are excluded from the need for disability insurance. However, having a low-risk job does not decrease your chances of a disability. According to the Council of Disability Awareness, a majority of disabilities come from illnesses and not from accidents, meaning it can happen to anyone no matter their occupation.
Disability insurance is most recommended for people with full-time incomes with one exception: Those with sufficient funds to retire, but are choosing to continue working. For this group, income replacement is no longer necessary.
If you are a millennial, it is crucial to protect your ability to provide for yourself at a young age, especially if you are someone who is paying off student loans and other debts.
A question you may be asking is, "why would I purchase long-term disability insurance when I could file for Social Security disability insurance?"
Social Security benefits aren't based on income or how severe the disability is, and pay an average of $1000 a month, which isn't enough to even replace even a minimum-wage full-time income.
More importantly, odds of approval are slim and payments may not begin for years. According to the Disability Benefits Center, 64% of applicants are not approved for benefits in their first round. Even if you are eligible in your first round, cases can take up to three years until payments begin. Because of all this, you should have a backup plan like private disability insurance to cover your expenses.
Workers' compensation is a type of insurance that provides wages to employees that have experienced an injury during employment. Although workers' compensation can be beneficial, it is only applicable to work-related injuries. According to 2016 statistics, only one percent of Americans missed work because of a work-related illness or injury.
According to the Council of Disability Awareness (CDA), the leading causes of long-term disability include musculoskeletal problems, cancer, and cardiovascular diseases. Workers' compensation does not cover these problems.
For long-term disability insurance, experts recommend buying an individual plan. When purchased as a group plan from an employer, many times, the benefit rates are not as high, and the benefit period may not be very long.
Another thing to consider is that you can not take employer-sponsored insurance with you. Once the job is gone, so is your protection; therefore, it may be best to have an individual private plan that stays with you.
However, short-term disability insurance is usually less expensive to purchase through your employer than another source. The reason is that what you are really purchasing is additional coverage on top of an existing short-term policy that benefits your employer. Companies purchase short-term disability policies on employees so they can cover outsourcing, overtime, and hiring costs associated with an employee suffering a disability. That coverage you purchase is just an addition to the policy that benefits you, and may be only 10%-20% of the entire policy benefit.
For long-term disability insurance plans, the cost is typically 1% to 3% of your annual salary. Therefore, if you are making a yearly income of $60,000, you can expect to pay $600 to $1,800 a year on disability insurance (or $50 to $150 per month).
It is typically recommended not to buy a short-term plan unless it is provided through your employer, as private short-term plans are known to be extremely pricey. If your employer does not offer it, then you may want to just focus on your emergency fund. Some states offer a public short-term disability plan to cover this gap.
Like with any insurance plan, there are things that impact the cost of your premiums. Here are a few factors that will typically affect how much you pay:
Your age and health: as your age or health problems increase, so will the amount you pay for your insurance.
Your gender: women tend to file more claims; therefore, they typically pay higher rates. This primarily applies to short-term disability because of pregnancy.
Income: The higher your income, the more you will pay to protect it.
Your occupation: If your job has a high risk of injuries, you will pay more.
Smoking: Those who smoke pay much more for insurance.
The taxability of the benefits is dependent on who pays the premiums, what type of benefits you are receiving, and if you are paying for the premiums with pre-tax or after-tax dollars.
Thankfully, the rules regarding taxation around individual disability insurance policies are relatively simple. Typically, benefits are not taxed if you paid the premiums yourself with after-tax dollars.
However, there are different rules for employee-sponsored group plans. If you are on an employer-sponsored group plan, then the taxability is dependent on who pays the premiums. If your employer is the one paying the premiums and they do not include your gross income in the cost, then your benefits will be taxable.
Private individual plans usually are not taxed, while employer-sponsored, government-issued, and group plans are usually taxable.
Most employers offer short-term disability insurance that covers most, if not all, of the premiums. If your employer provides it, you can sign up for employer-sponsored coverage. There are currently five states and one territory, according to the Society for Human Resource Management, that require short-term disability benefits: Hawaii, New York, New Jersey, California, Rhode Island, and Puerto Rico.
Even if an employer does not pay for disability coverage, they may still offer it as a voluntary benefit. Therefore, another option is to buy disability insurance through your workplace. This way, you will receive a group rate if you pay through the company's broker.
Plans through an employer are most commonly "guaranteed approval," meaning you won't need to undergo a medical exam or have any health qualifications.
You can also consider buying your own individual disability insurance plan. You can purchase disability insurance from an insurance company or a broker. It is important to note that most individual disability plans are long-term, although you can find some companies that offer short-term.
Insurance companies will have varying qualifications of what constitutes a disability. Some policies may cover any type of injury, while others only cover injuries to specific areas. Make sure to talk to a professional about your policy rules and expectations.